Terra (LUNA)’s price plummeted after the network’s TerraUSD (UST) stablecoin lost its peg. After posting significant gains earlier this year, LUNA has fallen by more 50% in the past 24 hours. If you are wondering Why Terra Luna cryptocurrency dropped so much, then keep reading.
First, don’t panic if you own Terra Luna. The fact that it went from over $100 per coin to now $0.00034 is outstanding and downright scary. But we are used to it in the crypto market. It’s always ripe with volatility. Not to this extent but it’s there.
The best to do in these situations is dollar cost averaging, or to hold if you are in the market long term. Trading is also an alternative if you are knowledgeable on charting reading and price movement to be able to get in and out of the trade with a profit.
The attraction of stablecoins is that — in theory — they aren’t affected by the price volatility that impacts other cryptocurrencies. However, in yesterday’s crypto crash, the value of 1 UST sunk as low as $0.66, according to CoinGecko, eroding confidence in the entire Terra network. At the time of writing, UST is trading at $0.92.
How UST lost its peg
There are different types of stablecoins, each of which carries its own risks. For example, Tether (USDT) and USD Coin (USDC) are both fiat-backed stablecoins, which means they should have $1 in reserve to support each token they issue. But there’s not always a lot of transparency surrounding those reserves.
UST is an algorithmic stablecoin, which means computer codes work in the background to maintain its price. Essentially, smart contracts burn or mint UST or LUNA, Terra’s native token, to increase or decrease the value of UST. As we wrote a few weeks ago, the risk is this system may not hold up against extreme price volatility, causing Terra’s stablecoins to de-peg.
LUNA soared earlier this year, in part because of the high demand for UST on its Anchor Protocol. Anchor promised APYs of almost 20% on UST deposits, which is all very well when times are good. Unfortunately, as we saw this weekend, the system may not be sustainable during times of extreme turbulence and panic.
The Luna Foundation Guard, a nonprofit dedicated to supporting the Terra ecosystem, has been buying Bitcoin (BTC) in recent months as part of a fund that’s designed to prop up Terra’s stablecoins. It’s working toward a reserve fund of $10 billion, intending to prevent any de-pegging incidents. This is good in theory, but in practice it did not work.
When UST first lost its peg over the weekend, the Luna Foundation tweeted that it would make two $750 million loans, one to accumulate BTC and the other to protect the UST peg. The price of UST continued to drop. As jitters over UST spread, more investors tried to sell, causing what’s best described as a run on UST.
The founder of Terraform Labs, Do Kwon, blamed deliberate market manipulation. But neither his words nor the efforts of the Luna Foundation could stem the flow. Other top cryptos are starting to stabilize after heavy losses in recent days. However, LUNA’s price continues to fall and 1 UST is still not worth $1.
What it means for investors
Decentralized finance (DeFi) promises to take the middleman out of traditional financial services, offering high rates of return on deposits, reducing fees, and making banking services more accessible. However, as recent events demonstrate, it is a work in progress.
Some aspects of DeFi overturn banking models that have taken decades to develop, including the consumer protections that many Americans take for granted. Those with UST on Anchor’s platform may be able to earn high rates of interest for a short time, but there’s a risk. If UST collapses, as other algorithmic stablecoins have, those investors would lose it all.
Not only did Terra’s reserve fund fail to hold up the value of its stablecoin, some say Luna Foundation’s rush to sell Bitcoin flooded a falling market with even more BTC and could have caused prices to drop even further. Both LUNA and UST are in the top 20 cryptos by market cap and if they fail, it will add additional pressure to the wider crypto market at what is already a worrying time.
Will Luna recover?
The coin has the potential to recover, but at present things are extremely uncertain.Do Kwon, founder of Terra creator Terraform Labs, tweeted on Tuesday: “Close to announcing a recovery plan for $UST. Hang tight.”He added on Wednesday: “I understand the last 72 hours have been extremely tough on all of you – know that I am resolved to work with every one of you to weather this crisis, and we will build our way out of this.“The Terra ecosystem is one of the most vibrant in the crypto industry, with hundreds of passionate teams building category defining applications within… Terra’s return to form will be a sight to behold.”
Reference : fool.com